Risk
Hedging
Taking an offsetting position to reduce a specific risk you do not want.
How it works
A hedge is a deliberate trade-off: less exposure to one variable, in exchange for a cost and often for some of the upside as well.
Common examples are currency hedges on foreign holdings, put options on an equity position, and futures used to reduce market exposure without selling the underlying holdings.
Where it misleads people
Hedges are rarely exact. Hedging one thing with a related but different instrument leaves basis risk — the two can move apart at precisely the wrong moment.
Related terms
- Currency riskThe risk that exchange-rate moves change your return on a foreign holding.
- Put optionThe right to sell an asset at a fixed price before a set date.
- Tail-risk hedgingDeliberately paying a small ongoing cost to limit losses in a severe market fall.
- Futures contractA standardised, exchange-traded agreement to buy or sell something at a set price on a future date.
- Basis riskThe risk that a hedge and the thing it hedges stop moving together.
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Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.